The purpose of this blog is to bring forth a simple 4-step stock investing process. Retail investors can implement it to invest in stocks and practice it professionally. The 4-step process might look simple but that is what makes it special.
Introduction
Direct stock investing can fetch better returns than mutual funds, real estate, gold, etc. It is a historical fact. But retail investors prefer mutual funds.
Practicing investment is a deep thing. We can draw parallels between our job and investment. Why do we do a job? To earn money, right? Similarly, we invest money to make our savings grow and compound over time. But consider this, can we do our job well by delegating responsibilities? No. So how come we expect good results by delegating our investment responsibility?
How do we delegate our investment responsibility? By investing through SIPs in mutual funds. This way, the money gets invested automatically each month without our intervention. In a way, it is better than not investing at all. But it is also a fact that everyone else is doing the same thing. Hence, it will only earn us returns like everyone else, the average.
Why do we delegate? There could be two reasons for it. First, we are busy with our work and life so automatic investing (SIP) looks like a better alternative for investment. Second, we do not have the necessary know-how to invest in stocks directly.
In case one wants to earn better returns, the delegation must stop. How to invest without delegating? By buying stocks on our own. Learn the process of stock investing and we can stop delegating.
Video [Hindi]
SIPs vs Direct Stocks
People prefer to keep their investments on autopilot (SIP).
- Through the SIPs, people invest regularly and earn average but market-beating returns. If the Nifty and Sensex are growing at 12% per annum, and SIPs fetch 14%, people consider it an acceptable result.
- SIPs are also favored by the mutual fund industry. It opens an assured and regular revenue channel for them. Every month, fresh funds for investment pours in. Mutual fund schemes keep their cut and the balance is invested.
- The stock market is also happy as, through the mutual fund SIPs, new money is getting invested regularly. It keeps the market touching new highs time after time.
It is like a win-win situation for people, the mutual fund industry, and the market. This is the reason why virtually no one objects to the SIPs. But do you know which is the weak link in the SIP system? It is us, the people.
We are satisfied with low returns. We are comfortable with not investing on our own and letting others (mutual funds) do it for us. These entities can only fetch us average returns as they are investing on behalf of the majority.
Allow me to give you a snapshot of a portion of my stock portfolio. As of Dec’2022, the CAGR returns have become more inflated than normal, thanks to the COVID pandemic and its after-effects on the Indian market. Over time these returns will subside and show values closer to pre-pandemic levels. But still, it will be higher than what mutual fund SIPs can promise us.
What is the point?
The fact is, if we can learn to invest in stocks on our own, we can fetch ourselves better returns. Allow me to share with your a ridiculously simple method to invest in stocks. It is a 4-step process and I’m sure anyone can implement it.
The 4-Step Process To Invest in Stocks
The infographics display a four-step process of stock investing being executed in loops time after time.
Let’s see each of the four steps in more detail.
Step#1: Analyze
In this step, the idea is to identify fundamentally strong stocks and add them to a dynamic watchlist. A static watch list will not work. People who know fundamentals analysis can identify strong stocks on their own. One can also create a dynamic in Google Sheets for free using attributes of Google Finance.
An alternative way to identify strong stocks is by using the Stock Engine (App). There is an algorithm in the Stock Engine that rates companies based on the following six parameters:
- Growth
- Profitability
- Financial Health
- Quality of Management
- Economic Moat (Competitive Advantage), and
- Price
The aggregate score of a stock, based on the above six parameters, is represented by a Overall Score (sale of 1 to 100). A stock whose score is higher than 75% is considered fundamentally strong. This overall score algorithm makes the identification of strong stocks easy for the app users.
The app also helps people to add stocks to the watchlist. It can be done with a single click of a button. Open the stock page, and click the “watchlist” icon to add it to the watchlist.
Once a stock gets added to the watchlist, review the watchlist by clicking on the portfolio icon on the top menubar.
Step#2: Save
In this step, the investor would save money. The idea is to create a separate investment fund. There is a strong logic behind it. I’ll suggest you read this article on the concept of paying yourself first.
When other investors buy mutual funds using SIPs, stock investors accumulate cash using Recurring Deposits (RD). The purpose is to hoard liquid cash and use it to buy stocks when the opportunity comes.
Imagine yourself running out of investment funds during the Covid crash of Mar’2020. It would’ve felt awful, right? Suppose you had a watchlist of fundamentally strong stocks. You track those stocks regularly. In Mar’2020, you found that the price of these stocks suddenly falls by 35-40%. Now, you are desperate to buy these stocks, but you have no cash. How would you feel? Desperate right?
During such times, cash stacked in the bank’s recurring deposit account can be the savior.
As important as it is to stay invested, it is equally essential to keep accumulating cash. This saving practice will never make us feel starved when the opportunity comes.
“Be patient, and keep doing RD when others are boasting about their SIP Returns” 🙂
Step#3. Observe & Wait
In this step, the investors are doing nothing, they are just observing the market and the price of stocks in the watchlist. When the market corrects or crashes, it drags down with itself all stocks. It then creates a good investment opportunity.
Waiting for a price correction may sound easy, but it is far from it. To make waiting easier, the preparation of a watchlist will help. When one must focus on the watchlist? When there is news that the Sensex and Nifty have corrected by 4-5%. When Index is down by about 4%, individual stocks will be down by about 8-9%. This is the time when one shall open the watchlist and compare the intrinsic value with the current price.
If the intrinsic value still looks too low, open the stock page and check the last day’s price trend. Check the last 14-days, 30-days, 90-days price, etc price charts. If the price of your stocks has fallen by more than 8-9%, it might be a good time to start buying. Do not invest all the money at once, gradually invest the money as the market continues to slip down.
Please note that, the market corrects itself every 1.5 to 2 years and there is a crash every 10-years. What does it mean? It means, withing a time span of 10-years, there will be at 5 to 6 good buying opportunities. If we can keep this pattern in mind, we’ll not get confused and lured with stuffs like SIPs etc.
Step#4. Buy and Hold
When the market is down, it is the right time to accumulate blue-chip, strong stocks.
Experts like Warren Buffett advocate a very long holding time for stocks (like forever). But there is a caveat. Not all stocks are suitable for long-term holding. Only fundamentally strong stocks, with a wide-moat qualify for such preferential treatment.
When good stocks are held for a very long term, they reward their investors by the way of fast compounding. Suggested Reading – what are compounding returns?
Furthermore, please remember how long one has waited to accemulate good stocks. Once you’ve bought these stocks at a discount, selling them too soon makes no sense. One must give them at least 10-years years time to show the power of compounding.
Conclusion
If a retail investor can follow this 4-step process to invest in stocks, the probability of earning high return becomes enhanced. The process might look ridiculously simple, but it is effective.
Above is the price chart of Nippon Nifty Bees ETF in the last 10-Years. I’ve marked the correction and crash that happened in this duration. There were at least five corrections and one crash as shown above.
In this duration, Nifty Bees ETF grew at the rate of 12.9% per annum. Investors, who followed the above 4-step process, would have accumulated strong stocks during these corrections and a crash. Following this investment process, he/she can comfortably surpass the 12.9% returns benchmark. The numbers are much higher, but I’ll keep it to myself as I do not want my readers to go overboard.
Final Words…
Out of all the steps mentioned above, I give a lot of weightage to cash accumulation (#2) and waiting for a price correction (#3). But to win the overall battle, it is essential to identify strong stocks and prepare a reliable watchlist.
My advice to new investors will be to avoid investing in small cap stocks. Start will large and mid-cap stocks having a high overall score.
A quick tip will be to prepare yourself for some waiting. To take advantage of the above 4-step process, one must lear to wait and spot the corrections.
“The big money is not in buying and selling, but in waiting”
– Charlie Munger
One Response
Very good article